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Investors in hedge funds have begun trading interests in side pockets, the structures used to hold hedge funds' least liquid assets, in the latest sign of distressed players putting faith in the recovery of the industry and wider valuations.

Elias Tueta, co-founder of Hedgebay, a private exchange via which investors trade their interests in hedge funds, said the buying and selling of investments in the least liquid portion of portfolios had begun last month.

He said that, before this development, investors were loth to invest in side pockets, as the structures were often put in place specifically to isolate from forced sales "those assets that hedge fund managers could not sell in last year's illiquid markets".

More than 100 European funds barred investors from pulling out all their money at once late last year, as redemption requests mounted, and markets dried up. That in turn made in very tough to realise value by selling assets.

Placing assets in side pockets was one of the most extreme ways managers locked investors' money into portfolios, as pocketed assets remain entirely immune from forced selling.

Managers contended they did this because it was impossible to put a "fair value" on the assets. Investors argued that managers did not want to sell them, and offloading them was still possible, even if at a poor price.

Now, said Tueta, investors were showing some interest in buying the holdings in such structures, although purchases were being made at an average discount to net asset value of 50%.

"The buyers [of side pockets] are family offices and some funds of hedge funds. The assets in them could be a mixed bag, but there must be some jewels in them that investors want," Tueta said.

Previously, investors only traded interests in hedge funds' more liquid assets on Hedgebay.

Tueta said increased demand for illiquid assets was clear last month when, for the first time this year, an interest in one fund changed hands at its net asset value. Every other transaction on Hedgebay this year has been at a discount to NAV.

He did not name the fund, but said it was a portfolio that "recovered well after redemptions in the first quarter", and took in new money before closing to new investors in June. After this, secondary markets became the sole route in, he added.

On average, interests trade on Hedgebay at a 12% discount to their NAV, which is about half the 25% average discount seen late last year, when supply was strongest and demand weakest.